from Follow the Money

Not so big worries for big oil — even at $60 a barrel, oil is rather expensive

October 24, 2006

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I would be the first to concede that $60 isn't $80.  Or even $70, the average price for oil (at least the good sweet light easy to refine stuff) in the second and third quarter.   US consumers - at least those in those parts of the income distribution that haven't seen big rises in their nominal-let-alone real wages -- were starting to feel really squeezed with oil at $80.  Now, they can afford to fill up their tank and still buy at least a few things at the local Walmart.

But the premise behind Chip Cummins' A2 Wall Street Journal article still seemed a bit off.  If you invested in a lot of oil fields that were expected to be profitable if oil averaged $20 a barrel, you will certainly make more money if oil is at $80 -- or even $70 -- than if oil is at $60.   But I am pretty sure that you will be making money even if oil is hovering around $60 a barrel.

Equity markets are not my thing.  But given the change in the trajectory of oil prices, I cannot imagine that anyone holding an oil companies' stock would expect oil companies to be able to sustain the kind of revenue growth they enjoyed when oil was steadily climbing up now that oil is falling.   So, unlike Cummins, I would hardly define a slowdown in oil profits as a "big problem":

"With crude prices falling and oil-field costs on the rise, major oil companies have a big problem: sustaining their phenomenal profit growth." 

Oil companies should make less money in q4 than in q3.  So what?  They will still be making a ton of money.

The same basic logic applies to most oil exporting countries.  They aren't going to be quite as flush with cash as they were in q2 or q3.  But they will still be very flush.  

Any oil exporter that faces financial difficulties with oil at $60 has done a terrible job of managing the oil windfall.  I have long thought that most oil exporters were a bit too conservative with their budgets -- as many were still budgeting for oil at $25-30.  But there is a still a big difference between $30 and $60.  

$60 is still, I think, higher than the average oil price in 2005.   Indeed, if someone had told me two years ago that oil at $60 would be widely considered a positive for the US economy (and a negative for oil companies), I wouldn't have believed them.   

Then again, if someone had told me two years ago that China could double its reserves, only partially sterilize the resulting reserve increase and still have (CPI) inflation of less than 2%, I wouldn't have believed them either.

Oil companies -- at least private oil companies in the US and Europe -- do face a big future problem.  It isn't oil at $60.  It is that they aren't likely to be able to replace their existing oil fields -- oil fields that generally were developed with the expectation that oil's long-term price was well below $60 -- with comparably cheap fields.  

Oil fields that were meant to turn a profit if oil averaged $20 will need to be replaced by oil fields that will only turn a profit is oil is well above $20.   Hey, that's life.   No country with oil should be selling their oil forward at that low a price right now.  

See James Hamilton over at EconBrowser.

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